Stability Brown meets the global boom-bust cycle

By William Keegan / THE OBSERVER , LONDON

Stability breeds instability. That is the economic and financial paradox that lies behind the recent ups and downs in the financial markets.

Here in the UK we have lost count of the number of times Chancellor of the Exchequer Gordon Brown has boasted about his policies of economic "stability." There was a famous British gardener several centuries ago called Capability Brown, and our chancellor would no doubt like to go down in history as Stability Brown.

Capability Brown was no ordinary gardener -- at the very least he liked a country estate on which to apply his skills. And Gordon Brown is no ordinary chancellor. One minute he is bringing stability to the UK, the next he is trying to bring stability to Africa, on a lightning tour with U2's Bono.

Just by chance, the biggest fall in the London stock market for years took place while Brown was away in Africa. Like TS Eliot's Macavity, the chancellor always seems to be away from the scene at embarrassing moments.

And when stock market declines hit the front pages, you can be sure people are worried. "Stocks can go down as well as up" is the warning financial institutions issue in the smallest of small print when trying to lay their hands on your money.

Both for the layperson and the expert recent events have been confusing. One day the markets seem to be collapsing, the next they recover. But behind all this we may well be witnessing the end of a long bull market, that has produced classic business-cycle excesses.

When examined, the concept of stability as employed by the likes of Gordon Brown refers to stable inflation and stable public finances. No crises, no "boom and bust" -- just steady economic growth and low unemployment.

The problem is that reasonably stable inflation, as measured by the average price of the goods and services we buy, has been accompanied in recent years by huge increases in the prices of assets, both physical (real estate) and financial (shares quoted on the stock market). Low interest rates encourage excessive borrowing and the rise in property prices (used as security for extra borrowing), both in the US and UK, has nurtured the feeling of wellbeing reflected in the stock market. Other classic signs of excess have been seen in the way the speculative boom has spread to commodity markets.

One of the greatest authorities on financial markets in the world is William White, chief economist at the Bank for International Settlements in Basle, Switzerland (the "central bankers" bank). After the inflationary decades of the 1970s and 1980s the view became fashionable in certain circles that all economic policy makers needed to do was to provide an atmosphere of stable inflation, and everything would be fine and dandy. But White concludes in a recent paper ("Is Price Stability Enough?") that "we now have a liberalized financial system which seems much more likely to show boom-bust characteristics than the previously repressed one."

The average person sees the excesses of a liberalized financial system in the almost daily invitations from banks that drop through the letter box urging him or her to borrow more. In the financial markets there is all manner of what is known as "financial engineering" with various exotic labels, which all boil down to the attempt to make a fast buck, preferably with other people's money.